Research On Trade Policy Flexibility Mechanisms In The WTO

States join international institutions and enter into international trade agreementsbecause they derive benefits from making binding commitments to one another. Thedesire to cooperate with other states further compels them to enter into internationallaws governing trade behavior and ultimately further perpetuates states’ compliancewith those international trade laws. The World Trade Organization represents such aninternational agreement.Concurrently, all states have an interest in breaching thesecommitments, especially exogenous shocks which are not provided by the designersof the treaty. Almost all international trade agreements include some form of“safeguard” clause, which allows countries to escape the agreed obligations. On onehand, such escape clauses are likely to erode both the credibility and the tradeliberalizing effect of international trade agreements. Flexibility tools that are too easyto invoke will encourage self-serving behavior and lead to a breakdown incooperation.Measures adopted to implement and enforce those flexibility mechanismsare also likely to distort trade by influencing the competitive balance betweenproducts and services that is governed by WTO rules. On the other hand, theyincrease the flexibility of the agreement by adding some discretion for nationalpolicymakers. Flexibility mechanisms function as “safety valves” to allow fortemporary loosening of the ties that bind.For this reason international institution thatinclude an escape clause generate more durable and stable cooperative internationalregimes. A major challenge facing treaty negotiators is to select a suite ofappropriately constrained flexibility mechanisms that facilitate agreement amongstates ex ante while deterring opportunistic uses of those mechanisms ex post after thetreaty enters into force.This paper mainly analyzes trade policy flexibility mechanisms in WTO regime.WTO is a bunch of multilateral trade agreements and as such the internationalequivalent of contracts. According to incomplete contract theory, WTOagreements are viewed as an incomplete contract in the international level, whichapplies as well to every other existing trade agreements. Because governments faceenormous uncertainty when designing a trade agreement, they do not possess full knowledge of domestic political and economic situations, nor anticipate the possibletrade policies and instruments that their trade partners might concoct in the course ofthe contractual performance.WTO framers were well aware that the WTO Agreementsmust leave injurers with some necessary “breathing space” in case unforeseen marketaccess contingencies occur,which would justify temporary or permanent, partial ortotal ex post non-performance. In the context of a multilateral trade agreement, suchas the WTO, non-performance by its members can be classified as extra-contractualand intra-contractual behavior. In other words, ex post non-performance, or breach, ofpreviously agreed contractual commitments can occur in two ways: the firstpossibility of non-performance is constituted by extra-contractual, illegal behavior.The subsequent remedies will be punishment or sanctions. Extra-contractual breachbehavior and the subsequent punishment will be bundled together in the term ofenforcement. The WTO deals with issues of enforcement mainly in GATT/GATSarticle XXIII and DSU article21and article22. Another kind of non-performanceforms an integral part of the contract, not a violation of the terms, therefore representspermissible, legitimate behavior. This arrangement is called escape, default, or excusefrom obligations. The subsequent remedies will be compensation or indemnity. Acombination of a rule of intra-contractual non-performance and the accompanyingremedy procedure together establish a trade policy flexibility mechanism in the WTO.This paper holds that the optimal design of international trade institutions needs tostrike a balance between commitment and flexibility. However, the WTO currentsystem does not provide the optimal trade policy flexibility for contractual escape,and therefore is profoundly flawed. This situation may consequently lead, or alreadyhave already led to excessive breach by the WTO members. This paper argues that theWTO legal framework provides WTO Members with a balanced compromise betweenlegal security, flexibility and economic efficiency should be viewed as being a merelysubsidiary factor under the current design of the WTO’s dispute settlement mechanism.Therefore, trade policy flexibility mechanisms are not reduced to liability rules, forinstance, those instruments assigning the discretion to injurers. Efficient breach theory,which is supported by a liability rule, only explains part of the nature of WTO legalregime, such as why signatories of WTO explicitly grant its members the right to usecontingency measures. Under this circumstance, aggregate welfare is larger if theescape mechanism exists. Though there has been a heated debate over the nature ofWTO obligations, this paper takes the view that WTO obligations can either be bilateral or collective, it depends on the nature of specific WTO entitlement. Becausethe WTO market access obligations are bilateral, it is appropriate to protect relevantmarket access entitlements by liability rules. Collective obligations (such as humanrights obligations) do not imply a promise towards individual states, but towards thecollectivity of all state parties taken together.It is better to protect the entitlements byproperty rules. In the case of WTO obligations treated as indivisible obligations, it ismuch properer to protect relevant entitlements by inalienability rules. For example,the TRIPS Agreement sets out the minimum standards of protection to intellectualproperty rights. It is reasonable to protect minimum standard entitlements byinalienability rules. A final strategy for remedying contractual incompleteness is todeliberately delegate gap-filling authority to previously uninvolved, impartial thirdparties. In the context of WTO, dispute settlement body engages in gap-filling in away that members would have consented to ex ante, had they foreseen the existenceof the contingency at hand. In a word, the paper tries to establish a preliminaryframework on optimal level of entitlement protection for the multilateral tradingsystem. This paper is divided into five parts.Chapter One gives an introduction to incomplete contracts and engages in an analysisof the WTO based on contract-theory, and establishes that WTO is an incompletecontract concluded between self-interested and rational trade policymakers. In reality,it is impractical and infeasible to make a complete contract, because the parties cannot fully foresee the future. Various factors suggest that contracts are inevitablyincomplete. Bounded rationality in the context of contracting in international trade,transactions costs associated with contracting and strategic ambiguities of the partiesare reasons for contractual incompleteness. Prior to the conclusion of the WTOcontract, no country possesses full knowledge of the nature and impact of futureevents, or of the possible trade policies and instruments that its trade partners mightconcoct. Nor can it anticipate whether these contingencies will make it victim orinjurer. There are costs associated with defining all possible contingencies during theprocess of forming the contract, writing a formal contract and negotiating the contract.The contractual silence or ambiguity in the WTO text creates different expectations asto the interpretation of the contract, which may be the outcome of its members’purposeful drafting in order to derive some individual benefit. Contractual loopholes,economic environment and domestic political uncertainties are the theoretical basisfor the existence of WTO trade policy flexibility mechanism. Due to contract incompleteness, the parties are facing a non-trivial dilemma: they wish to reach astrong and binding agreement, at the same time to have more wiggle-room whenperforming the agreement. Hence, the designs of international agreements, especiallytrade agreements, tend to include more flexibility mechanisms, to give contractingparties flexibilities for implementation. In doing so, contracting parties are willing toaccept the incompleteness of the agreement, and make use of the opportunities in theagreement. This chapter also discusses the influence of contractual incompleteness onthe contracting parties. Too much flexibility in an agreement will lead to thepossibility of its abuse, such as engendering opportunistic behavior whenevereconomic, political, or other pressures make compliance inconvenient; too muchuncertainty or too rigid in an agreement will prevent states from reaching a contract atthe very beginning, or is likely to result in widespread violations. In order to managethe risks, states often draft an array of flexibility mechanisms and incorporate theminto the agreements they negotiate. Besides, they also devise a series of gap-fillingstrategies to deal with contractual incompleteness.Chapter Two first analyzes standards to judge the legitimacy of unilateral trademeasures in the WTO. Members of the WTO have a legal right under internationallaw to engage in unilateral measures to resolve trade-environment issues, but theunilateral use of trade measures to force other countries to comply with a policyunilaterally prescribed by the importing country conforms to neither the WTO law northe customary international law. This paper then examines the legal definition ofWTO trade policy flexibility. Trade policy flexibility instruments are to be defined asany intra-contractual, legal provisions that legitimize ex post discretion in the form ofa departure from performance as originally promised. Trade policy flexibility has alsobeen termed “structured defection”,“selective disengagement”, or “safety valve” inthe literature. The WTO provides for several formal, de jure, trade policy flexibilitymechanisms. Examples in the General Agreement on Tariffs and Trade (GATT) articleXII (restrictions to safeguard the balance of payments), article XVIII (infant industryprotection and balance of payments crises), article XIX (Emergency Actions onImports of Particular Products, also known as the “safeguard measures”), articleXXVIII (modification of schedules, also known as tariff renegotiation), article XXand article XXI (general exceptions and security exceptions). Similar examples oftrade policy flexibility instruments can be found in other WTO agreements, such asthe General Agreement on Trade in Services (GATS), the Agreement on Technical Barriers to Trade (TBT), or the Agreement on Agriculture (AoA). This “escapeclauses” were written in the agreement to increase flexibility. In addition to these dejure escape clauses there are various informal, de facto, flexibility tools available toWTO members,such as voluntary export restrictions (VERs), orderly marketingagreements (OMAs), antidumping (AD) and countervailing duty (CvD), subsidies, ora violation of the agreement. Those are ways frequently used by WTO members toescape initially made trade liberalization commitments. Resort to these instruments isoften in contravention of the letter of law, or at least the spirit of the agreement. Thischapter also points to the role trade policy flexibility plays in the WTO. First,flexibilities may serve as a safety valve, without which governments may feelpressured to renege on certain negotiated liberalization commitments. Second,contingency measures can be used as an insurance mechanism, which allowsgovernments to hedge against the risks associated with large degree of uncertainty.Third, trade remedies may represent an adjustment policy tool, which reducesvariations in the costs for the domestic economy when it is affected by external events.Fourth, contingency measures can act as a form of compensation that allowssignatories to accept a more rapid pace of trade liberalization.Chapter Three explores the theoretical debates on conflict and coordination betweenthe WTO treaty obligation and flexibility. In the WTO a fierce debate is raging as towhether the treaty requires countries to bring their trade policies in line with WTOdisciplines (specific performance under a property rule) or whether it permits, or evenpromotes, countries to “buy-off” their WTO obligations by paying compensation orsuffering from equivalent trade retaliation (efficient breach under a liability rule). Anumber of scholars claim that the WTO system would gain from allowing countries tobreach their commitments, as long as they would be willing to compensate all affectedparties. Those scholars who advocate “efficient breach” theory hold that WTO lawdoes not normatively demand compliance at all costs. They view the WTO disputesettlement mechanism itself as a system of breach and pay, or the WTO should allowmembers to “buy out” a violation. This approach to WTO enforcement is highlyinfluenced by economic logic and the paradigm of rational choice. Accordingly,entitlements under WTO law are protected merely by a liability rule, not only withrespect to the renegotiation and unilateral modification of tariff and services schedules,but also under the rules of the DSU where WTO members may in fact choose to eitherprovide compensation or endure trade retaliation, instead of rectifying an existing breach of obligation. Because there are many theoretical blind spots in the “efficientbreach”, it has never been accepted by the WTO Members. There is another disputecalled “compliance-vs.-rebalancing debate” in the WTO scholarship. The rivalry ofthe two camps has also been termed as “property vs. liability rule”,“legality vs.efficiency view”,“rule vs. efficiency orientation” or “contract vs. treaty view”.According to rebalancing proponents, the essence of the WTO-just like the precedingGATT–is a mutual exchange of market access opportunities that WTO Members grantto one another. The rebalancing approach is rooted in the conviction that the worldtrading system is fundamentally driven by reciprocal promises of trade liberalizationwhich give rise to a “balance of concessions”. It basically views the objective ofdispute settlement as supplying an insured safety-valve for injurers in a non-stationaryworld. By contrast, some scholars argue that WTO law is mandatory law withcompensation or trade retaliation being merely temporary solutions which do not seala final shift of entitlements. Both WTO enforcement mechanism and disputesettlement are designed to induce compliance and deter future violations. Complianceadvocates contend that the basic values and objectives cherished by the modern-dayWTO are security and predictability of the world trading system. This gravitation ofthe whole system toward rules suggests that rebalancing has been playing a muchsmaller role in the WTO context. Rebalancing or efficient breach are not central oreven operative in the normal DS processes.The theories mentioned abovehave some merits.However, neither the “property rule” nor “liability rule” stand alonecan provide comprehensive protection for the complex and diversified entitlements inthe WTO agreements.Chapter Four studies the flaws in current WTO trade policy flexibility mechanisms.The paper first turns to the empirical literature and examines whether thosecontingency trade measures has facilitated trade liberalization or given countries anopportunity to backslide on negotiated commitments. Contingency measures in theWTO such as safeguards, antidumping and countervailing duties, are partial solutionsto the “incomplete contract” nature of WTO agreements. Exogenous shocks that leadto surges in the demand for protection are precisely the type of event that cannot beforeseen by the drafters of the agreement. In general, these include situations whenthere is a sudden increase in competitive pressure from foreign imports. Relied ondata compiled by the WTO Secretariat, this paper argues that there are flaws in WTO flexibility enhancing devices. Firstly, the scope of de jure escape mechanisms isinsufficient. Secondly, informal flexibility instruments have the features of lowerenactment thresholds, possessing a broader scope of application, politically moreconvenient to policy-makers and accompanied by lower remedies. The differencesbetween two kinds of flexibility mechanisms make it difficult to draw a line betweenwelfare-enhancing contingency measures and opportunistic behavior of WTOmembers. Furthermore, the WTO applies the same remedy-substantially equivalentdamages to legitimate non-performance (e.g. GATT article XIX and article XXVIII)as well as to a violation of the agreement (DSU article22.4). This chapter thenexamines flaws in the system of enforcement. For example, intra-contractual andextra-contractual behavior is sanctioned in the same way, and extra-contractualremedies are systematically undercompensated. Furthermore, retaliation as amechanism of remediation poses grave disadvantage for WTO members. Firstly,retaliation is economic nonsense. Secondly, complaining party may have no interest inimplementing retaliatory measures, when both the economic and political costs areconsidered too high. The findings showed that WTO’ flexibility mechanisms andenforcement mechanisms didn’t function enough to promote better developmentoutcomes.Chapter Five gives advice to future directions of the WTO trade policy flexibilitymechanisms. Based on a model of individual freedom and welfare maximization–nowstandard assumptions of the law and economics school–Calabresi and Melamedprovided a three-step scale of protection for domestic legal entitlements. In their view,a first group of entitlements is best protected as “inalienable”(not to be transferred atall, not even by mutual consent); a second group as “property”(which can be taken,but only with the consent of the entitlement’s holder); a third group under a simple“liability rule”(the entitlement can be taken by anyone subject only to the obligationto pay full compensation for it). The idea of protecting entitlements under a mereliability rule, pursuant to a take-and-pay principle, subsequently developed into thebroader theory of “efficient breach”. The paper based on Calabresi and Melamedanalysis, discusses whether their mode finds its application in international law,especially in the WTO law. For example, how does international law currently protectentitlements? Does this current level of protection accord to the predictions under theCalabresi and Melamed model? Does it conform to the theory of efficient breach?What is the best way to protect the entitlements in the WTO? To begin with, we should determine the optimal level of WTO entitlements protection. Europeanabsolutism holds that, once allocated, international entitlements cannot be modified ortraded. Rather, they must be specifically performed unless, in the case of treaties, alltreaty parties agree to reallocate the entitlement. American voluntarism argues that,the allocation of international entitlements is a mere pledge which states can renegeon, based on a simple cost-benefit analysis. Put differently, international entitlementsare, at best, protected by a simple liability rule, a contract that can be broken with thepayment of compensation. This paper holds that, both schools‘s thoughts are driven toits extreme, and cannot represent the optimal level of entitlements protection.Secondly, given the WTO has agreements covering a wide range of issues, it is properto take different ways to protect specific entitlements. It is probably fair to say thateconomic rationale is the core of the WTO. After all, trade is about exchange of goodsand services, a profound economic enterprise. With reciprocal entitlements, the rightsof one member constitute the obligations of the other. However, just as reciprocalmarket access is not the sole rationale for contracting, market access entitlement is notthe only entitlement provided in the WTO. For instance, minimum standardentitlements in the Agreement on Trade-Related Aspects of Intellectual PropertyRights and Agreement on Import Licensing Procedures are different from thebilaterally owed market access-based trade entitlements that form the backbone ofGATT and GATS. Minimum standard entitlements are owed to the WTO membershipas a whole; their erga omnes partes scope is distinct from a bilateral logic. Therefore,it is reasonable to take different rules to protect WTO entitlements according to thenature of specific entitlement or obligation. For example, we can protect marketaccess entitlements by liability rules; protect the collective entitlements by propertyrules, and protect minimum standards entitlements by inalienability rules. Under aliability rule, one party has the option to take away parts of the other party’sentitlement unilaterally (i.e. without the owner’s prior assent), under the condition thathe compensates the owner for damages. Under a property rule, both parties are undera “specific performance duty”. However, a potential taker can buy off the owner’sentitlement through renegotiations. He can still avoid his commitments by securingpermission from the owner, usually by paying for it. Whenever signatories decide on arule of inalienability, they choose to prohibit any ex post flexibility. Despite theoccurrence of external shocks, the originally established internal contractual structureis to be maintained once and for all. Human rights are an example of a set of ubiquitously accepted inalienable rights that cannot be taken away or traded. Since acourt is required to settle urgent disputes at times, it is obliged to “fill the gap” whenlegislation is not sufficiently clear on some points in question. The WTO’s disputesettlement mechanism is one of the key instruments that states use to fill gaps andresolve ambiguities in this contract.